Many participants view options and the underlying asset as separate, but in practice they are closely linked through pricing relationships.
There are situations where the price of options implies a different value than the actual stock or futures. When this difference appears, certain strategies like conversion and reversal are often discussed as ways to capture that gap.
At the core of this concept is put-call parity, which shows how options can replicate the payoff of the underlying.
For example:
• Long Call + Short Put (same strike and expiry) behaves similar to a long futures position
This creates what is often referred to as a synthetic position.
In efficient conditions, the price of:
• Actual stock or futures
• Synthetic version created using options
should remain aligned after adjusting for factors like carry or interest.
When this alignment shifts, two types of structures are commonly observed:
Conversion (when options appear relatively underpriced):
• Buy the underlying
• Buy a put
• Sell a call
This structure limits both upside and downside, resulting in a defined payoff at expiry.
Reversal (when options appear relatively overpriced):
• Short the underlying
• Sell a put
• Buy a call
This creates a similar fixed payoff structure from the opposite side.
These setups are less about predicting direction and more about observing pricing differences between real and synthetic exposure.
Such differences may arise due to:
• Demand for hedging in options
• Changes in volatility expectations
• Dividend or carry-related adjustments
• Temporary imbalance in buying and selling pressure
Execution also plays an important role:
• Multiple legs need to be executed together (Use Strategy Builder)
• Costs, spreads, and timing can impact outcomes
• Shorting the underlying may involve additional considerations
Because of these factors, such strategies are often associated with participants who have access to efficient execution and lower costs.
This creates an interesting perspective where the focus shifts from direction to pricing relationships.
Have you observed situations where option prices and underlying movement seemed out of sync?